Guest article: R&D subsidy rates are too low to work

Business, R+D | Fri 25 Jan | Author – Business & Finance

Learning lessons from the UK and US on how best to fund R&D in Ireland

An outstanding piece of research which has valuable lessons for Irish industrial policy has recently been published by the University of Strathclyde* .This shows how the UK government lost no less than half a billion pounds sterling in direct subsidy of attempts to capture offshore ocean wave energy. As this only paid a part of recipient firms’ R&D costs, and their losses were tax-deductible in many cases, the total public cost must have been more than a billion. At the end, there was nothing to show for this except scrap metal.

The primary cause of this massive failure is identified by this research as the partial nature of the R&D funding, which is also characteristic of Irish public support of firms’ research and development.

The Massive British Failure

The Strathclyde study delivers convincing empirical confirmation that public funding of R&D by firms at any rate lower than 100% is actually a serious policy error. In the British wave energy case, the need for firms to provide matching funds distorted the entire process. Firms which had the money for this were seduced by the prospect of subsidy, so that they underestimated the severity of the technological challenge. Then, to try to get a return on their investment, they focussed on full scale equipment they hoped could produce saleable energy, without having found the faults in it by earlier testing: As a witness in the Report put it, ‘To get access to subsidy, people had no choice…they cut steel and built something to go in the water and it broke.’

Irish commitment to partial funding

Partial public funding of firms’ R&D is the norm in Ireland, and the poor innovatory record of its indigenous firms reflects this. It is obvious why those who administer the awards should like this way of subsidising R&D. Firms without money to match awards are automatically excluded, and most of those which do have the money will only seek support for projects that are relatively ‘safe.’ Both of these factors cut down the numbers of applications that administrators have to deal with, and also reduce the danger to their career paths from being associated with failures. What is called ‘the Department of Finance view’ defends partial funding on the ground that those who have made their own investment in a project are more likely to be committed to its success. In fact, this is vastly less important than the commitment of individuals whose psychological ‘skin in the game,’ and not just financial investment, has been proved to be the crucial element in successful innovation.

Linear theory

At the outset, Irish public funding of research was based on a naïve linear theory of industrial innovation, according to which money invested in basic research would lead to opportunities for applied research, out of which new products and jobs were expected to come eventually. This view underwrote large subsidies to Universities through bodies such as Science Foundation Ireland, up to the time of the financial crisis. The reassessment of all public expenditure which this necessitated then called attention to ‘… the substantial amounts (nearly €1.5 billion) invested to date’ and ‘… the lack of verifiable economic benefits resulting from these investments’**. This caused the government to try to move the emphasis of public funding towards commercialization.

US Example

Unfortunately, in doing so, it held back from following proved United States example. An important aspect of the pre-eminence of that country in economic innovation has been that when its Government helps firms to innovate, it does so ‘with both hands.’ That is, it provides 100% of the cost of the research and development that is needed.

It is this level of funding that has made the US Small Business Innovation Research (SBIR) programs so extraordinarily successful (these should not be confused with the ’SBIR’ scheme of Enterprise Ireland, which ought to have been given a different acronym). The eleven US programs now provide more than $3bn a year to fund the total cost of R&D of projects in firms with up to 500 employees.

Risk and Uncertainty

Public funding at any rate lower than 100% only purports to deal with risk and low risk at that. Even for such projects, partial funding is self-defeating. In breaking new ground, it is rare to succeed the first time, and money which has had to be used to match public subsidy for the R&D, is not available for trying again. The US SBIR scheme, which provides a firm’s total R&D costs including its overhead, supports and encourages multiple attempts until success is finally achieved.

All radical innovations start in uncertainty, which is the stage before risk can be calculated. This is the position of any really new idea, and it means that the very first money that is invested to turn it into concrete reality – its seed capital – can only have an irrational basis. It cannot be made by any institution or individual through objective calculation, but only, as the saying goes, by ‘founders, family and fools.’ These may put money irrationally into a project at the uncertainty stage because they are emotionally biased towards the concept or its promoter. However, even when such funds are available, they are limited, so that public funding at the 100% rate is indispensable to fill the inevitable shortfall in seed capital for genuinely new and radical ideas.

An escape from partial funding

For any non-US firm which is pursuing a significant innovation, it actually makes more business sense not to gamble its own money in matching an offer of partial subsidy of its R&D. Instead, it could pursue a joint venture with a US firm. Such potential partners are very easy to identify from SBIR’s database (my students do it for practice). The combination would be eligible for SBIR’s 100% funding of the necessary R&D, as long it is at least 51% US-owned. The foreign firm would have to be content to be a minority shareholder, but it would have a obtained a valuable entry to the US market for whatever potential its innovation may have. Apart from this, it is far better off than if it had bet its own capital on an outcome that is not just risky, but uncertain. Good as SBIR is, in what is still the most receptive country in the world for anything new, empirical research has shown that the odds against an idea winning both stages of the R&D support, then finding venture capital, and finally becoming an established product on the market, are worse than going to the races and backing only outsiders.

Lesson learned

Although the lesson from trying and failing to exploit offshore wave energy was extremely expensive, at least the British government did learn it. The outcome of its experience was that Wave Energy Scotland was set up with a mandate to provide 100% funding of firms’ research and development in that sector.

Is it too much to hope that Irish authorities would free-ride on this convincing example and the story behind it, and bring the rate of firms’ R&D subsidy here up to the same level?

Or, at least until they do so generally, that Enterprise Ireland would be provided with money to make up the shortfall to businesses in awards they may win from other research funding Agencies, including those of the EU?

William Kingston is in the School of Business of TCD, and is the author of Interrogating Irish Policies.
  • *Hannon M, van Diemen R, Skea J 2017) Examining the effectiveness of support for UK wave energy innovation since 2000.. International Public Policy Unit, University of Strathclyde, Glasgow. Review Article by Kingston W. in Prometheus (2018): DOI: 1080/08109028.2018.1486534
  • **Government of Ireland (2009) Special Group on Public Service Numbers and Expenditure Programmes, Chapter 8.